Asset allocation tutorial?

Asset Allocation

Asset Allocation BY Asset Type 11-2007

BY Asset Type (%)

BONDS 15.9
CASH 8.9
NON-US STOCKS 21.6
OTHER 11.0
US STOCKS 42.6

Total: 100.0%
 
Now let's review what we have done so far:
1. We have registered at TRowePrice for free so we can use the M* tools there.
2. We have learned how to use the M* Instant X-ray tool to look at the 9-box style grid and see how an investment contains large, mid, small cap equities divided into value, blend, and growth type stocks.
3. We have learned how to use the M* portfolio manager tool to enter and save our portfolios and see how our portfolio is divided up among cash, fixed income, domestic stocks and foreign stocks.
4. We have learned how to use the M* portfolio X-ray tool to see the 9-box style grid of our portfolio.
5. We have learned a little bit about risk and reward.
6. We have read a few articles on asset allocation.
7. We learned that for equities there are two camps in equity asset allocation: (1) total market weighted portfolios and (2) the Fama-French slice-and-dice portfolios.

8. We have learned that we can dial in our risk tolerance by the amount of fixed income and cash that we hold in our portfolio. We have learned that whatever percentage of equities we have in our portfolio, that we can maintain the asset allocation among the equities the same in terms of percent large cap, small cap, foreign, domestic, value, growth, etc.

Here are a few more links to read to help review and cement your knowledge:
Building Your Portfolio: Investment Strategies for the 21st Century, by Frank Armstrong (Armstrong's article; similar to the Merriman ultimate-buy-and-hold article)
Portfolio Tactics: Investment Strategies for the 21st Century, by Frank Armstrong (Armstrong's next chapter, which includes some %fixed:%equities info)
FundAdvice.com - Fine tuning your asset allocation (Merriman's follow-on article, which includes some %fixed:%equities info)

To be fair, here is an online book by Rick Ferri that contains advice on investing in total market weighted style: Portfolio Solutions)


At the end of reading these articles, one should have a general idea of what percent fixed income and cash that one wishes to have in their portfolio. This will be a personal decision, but should be based on the risk level or maximum portfolio loss in a year that is acceptable to you or perhaps based on the desired long-term average annual return that you need. It can also be based on personal experience that you've had with your portfolio. For some help with this, you might take a look at Portfolio Solutions

http://www.portfoliosolutions.com/v2/pdf/The Asset Allocation Question.pdf which are both from Rick Ferri's (author of All About Asset Allocation) company's web site.

Homework: After some careful thought, tell us what your desired asset allocation in terms of %stocks, %fixed income is. Give us a sentence on why you chose that split. Tell us whether you are in the total stock market weighted camp or the F-F slice-and-dice camp or somewhere in-between. Then finally tell us how you want to split up your equities into domestic and foreign.

I know this is a little harder than the first homework of a simple instant X-ray. Take your time, there is no deadline. Next time we will enter "model portfolios" into our M* portfolio manager account and X-ray them, to see how the models stack up against the theory and our own portfolios.
 
14% cash
42% us stock
44% foreign stock
0% bonds
0% REIT

33 21 19
6 6 7
3 3 2

There is an almost equal amount to the above in real estate equity, split 80/20 between a rental property with no net income and our primary residence.

*want allocation centroid more toward small value. Anyone have an easy way to find centroid?
 
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Stock 75%
Fixed 25%

I have a long time horizon and at this risk reward level I would follow the strategy without abandoning ship.

F-F Slice & Dice Domestic 66% Foreign 34% of equity portion.
 
80 stock
20 fixed

Have a long term approach

total market strategy

60 domestic
40 foreign
 
65 stock
35 fixed

We will EA in 5 years+-, depending on my mood ;-) We have been running at 70/30, but I think it is time to become a little more conservative. I am comfortable with the market's ups and downs and we can handle some losses. We will both also have pensions in 5 years, as well as some rental income - so I feel comfortable in the 65-35 range. I suspect when we retire, I might slide that into the 60-40 range.

70 domestic
30 foreign

I think I am more towards the total market strategy spectrum, if I understood it correctly to be the "passive/index low-cost investing"?
 
3.06% cash
56.71% US Stocks
36.53% Foreign Stocks
3.20% Bonds

29 25 22
9 8 4
2 1 1

We are 5 years since retirement w/Cola'd pensions covering expenses. Portfolio/savings was originally planned to be one strong leg in our "three-legged-stool" of pension, savings and SS. Would like to grow the portfolio with a long range perspective - currently consider ourselves in the slice-and-dice category...

JohnP
 
JohnP, although you state you consider yourselves in the s-n-d category, your asset allocation is extremely close to a total stock market asset allocation (see eridanus's post #32 above).

KM - slice-and-dice can be implemented with a passive/index low cost investing.

This is getting ahead, but does anybody want to post the 9-box style grid for either the Merriman portfolio #6 or the Armstrong portfolio #5 which are both slice-and-dice portfolios tilted to small cap and value? Or how about the 9-box style grid for any of the lazy portfolios?
 
I'm leaning toward about a 50/50 mix of fixed income and stocks. The fixed income, absent some compelling and understandable logic, will be a combination of CDs, money markets, and secured property loans to juice up the yield on the CDs and MM. The income from that should be sufficient for at least the first year of retirement, inflation would reduce the effective income thereafter. The other half of our assets could be in stocks, with the aim being for them to grow without generating much taxable income. Need the stocks to grow at at least double the rate of inflation so that our effective income doesn't decrease. We have a pitiful amount that can be put in an IRA or other tax-sheltered account, so I want to buy stocks that don't pay much dividend to keep the tax load down. Druther do some simple-ish form of s&d as i feel that market weighted TSM exposes one to bunches of large cap and not much else. Like about 40% of the stocks to be foreign to recognize the emergence of a whole bunch of new consumers.
 
I'm a bit behind - second assignment results:

Report what percentage (round off) you have for cash, bonds, domestic stocks, and foreign stocks.
Cash 23
Bonds 22
Dom Stock 48
Foreign Stock 7

I have a ways to go on my reading, but just entering all my investments in one place like this was an eye-opener.

I have two old 401k's that I have been dragging my feet on rolling over to an IRA - got to move on that, if only to make analysis easier - among all investments - current 401k, Roth IRA, old profit sharing account, company stock purchase plan and the two old 401k's, I have 40+ different funds - some are duplicated.

I think working on cleaning this up will help considerably to simplify rebalancing.
 
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2nd assigment:

28 27 14
11 6 5
3 4 2

Cash 1.35%
Bonds: 1.21%
US stocks: 74.51%
Foreign stocks: 22.72%

37 funds and stocks. :( Evidently, I need more mid- and small-cap exposure.


(I have some cash in an active trading account, but I haven't included it.)
 
Sorry to be late turning in my homework. This working thing gets in the way of planning for retirement.

Current allocation is:
Domestic Stocks: 48%
International: 12%
Bonds: 20%
Cash: 19%
Other: 1%

Desired allocation:
Domestic Stocks: 40%
International: 10%
Bonds: 30%
Cash: 15%
Other (REIT) 5%

This allocation will provide a better stream of earnings and lower volatility. I'm intrigued with slice and dice, still figuring it out. Will also move to use of Index funds wherever possible to keep it simple.
 
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This is a great thread. I have been trying to figure out my ideal AA for a while and have not yet settled on what I want to do, so I am happy to get more food for thought here.

My current allocation is:
Cash 18.1%
US Stocks 65.7%
International Stocks 15.6%
Other 0.6%

16 21 26
6 9 8
5 6 4

My desired allocation is still up in the air, but I definitely want more international stocks and maybe some international bonds, too. Also, I've got too many US Large stocks, so I need to adjust that. A possible allocation:

70% Equity - split almost 50/50 Domestic/International and about 50/50
Large/Small
5% REIT
25% Fixed - split about 75/25 Domestic/International

I still don't really feel like I know what is best for me, but I have enjoyed the readings and look forward to more readings and assignments. Thanks!
 
LOL! said:
Homework: After some careful thought, tell us what your desired asset allocation in terms of %stocks, %fixed income is. Give us a sentence on why you chose that split. Tell us whether you are in the total stock market weighted camp or the F-F slice-and-dice camp or somewhere in-between. Then finally tell us how you want to split up your equities into domestic and foreign.
Click to expand...

I am thinking I will make a "preliminary" judgement on desired AA based on the 1970-2006 AA returns table presented in the "Fine Tuning Your Asset Allocation" article by Paul Merriman.

But I am also thinking, where can I find a similar table based on 1926-2006? I don't feel totally comfortable using the "short" 36 year history in Merriman's table for my decision making on AA. Considering that time frame included the great extended bull market of the 80's and 90's. And where can I find similar table not assuming a 50/50 split between domestic and international for equities?

But that aside, my prelimianry AA would be 70% equities/30%fixed income.

This because the 70% equities shows a worst 5 years return of a positive 7% and a worst one year return of negative 25%. And standard deviation of 11.2 and average annual returns of 12.4%. I would feel comfortable with those estimated risks over those time frames, and those estimated reward levels.

But that AA goal setting bases on Merriman's table is problematic, because I think I desire domestic/international split equity portion of maybe 70%/30% (not Merriman's 50%/50%), and I have no idea what historical returns data exists for such split.

So, my AA goal setting at this point is really then flying in the dark.

Where can I find more historical returns tables for different allocations and for longer timeframes? I need more data!
 
Here are some sample asset allocations analyzed by the M* 9-box style grid.

VTSMX - Vanguard Total Stock Market
24 24 24
6 6 7
3 3 3

VFWIX - Vanguard FTSE All-world ex-US
36 30 23
5 4 2
0 0 0

Thus the all-world index contains NO SMALL CAP! So a simple portfolio of VTSMX and VFWIX in the ratio 50:50 would be a little light on small caps:
30 27 24
5 5 5
1 1 1

What I hope will surprise some of you are how the typical slice-and-dice portfolios (Armstrong, Merriman, Swedroe, Ferri, DFA and other folks) are really tilted to small and value. For example, the all-equity ETF portfolio of Merriman with 10 ETFs each holding 10% of the total portfolio has a M* instance X-ray of 50% domestic stocks, 50% foreign stocks and this grid:
21 17 8
11 10 5
13 9 6

If we take the Armstrong portfolio 5 which has 60% equities and 40% bonds (I used the same ETFs as the Merriman ETF portfolio and used BND for the bonds) and X-ray it, one gets 30% domestic stocks, 30% foreign stocks with this grid:
23 14 7
11 8 5
14 11 7

In essence, the growth column is about 20% in the value-tilted portfolios in contrast to the total market value of 34%. The value column in the value-tilt portfolios is about 48% in contrast to the total market value of 33%.

Large cap is 72% of a total market weighted portfolio, but is only 45% of a small-tilted slice-and-dice portfolio.

Discussion: In looking over the responses to this thread, I did not see any small and value titled portfolios, though Darryl reported such a portfolio without any numbers. Some portfolios were tilted to the growth style which has been shown to produce inferior returns in the long term.
Are you surprised at how the numbers are for the small and value titled portfolios? Just add your comments to this thread.

Topics still to discuss:
Which types of accounts (taxable, tax-deferred, Roths) are the most efficient for which types of assets (fixed income, REITs, TIPS, large caps, small caps, value equities, etc).

What about fixed income investments, what to consider when choosing (i.e. diversifying) among TIPS, treasuries, munis corporate as well as long term, intermediate term, short term durations.

How do REITs, precious metals, collateralized commodity funds, and emerging markets fit in?

What about rebalancing?

(Also, I need guest lecturers to volunteer and add some posts here. Thanks!)
 
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Darryl, has not got his act together yet. Grid breaks out like this.

20 20 32
4 4 3
5 8 4

I did sell some bonds today and bought some more small value. I read the Merriman article some time in 2007 as a link from someone on this forum may have been you LOL :) I found it compelling and have been trying to move toward it without taking on a lot of transaction costs or tax implications. I've been a little surprised how hard it is to get the tilt (the world seems to be dominated by megacorps). I'm leaning toward some DFA funds with extra cash some in Dec. with more in Jan & Feb... Vanguard can help me with the small value & small cap domestic but my biggest gap is getting my foreign allocation and I'm thinking DFA is the answer to that. I also got distracted and bought some Berkshire B and though I wanted to make that part of the mix (not interested in REITS or commodities) it didn't help my efforts to move toward small value. I also own some LSGLX right now and it has been doing well but if you guys are aware of another world bond fund that is not closed to new investors or require 100,000 to open I am looking for a good one with a lower expense ratio.
On the other topics the traditional wisdom makes sense to me bonds REITs in pretax and low yield in after tax of course if you could know where the home run is at you want it in your ROTH as it's tax free winnings.
I love emerging markets and have no interest in commodities like gold or REITS nobody was trading gold in N.O. when Katrina hit that I have heard about and most of us are online at home some are at work and though I own a home and have owned rentals successfully in the past and probably again in the future. My thinking is that often Real Estate is just another word for overhead and overhead is a killer in a flat world.
 
Found a couple of articles at the Asset Allocation Advisor magazine might be of interest to readers in this thread.

First article talks of quantifying one's risk tolerance. Need to know that before settling on an AA.

http://www.aametrics.com/pdfs/quantifying_risk_tolerance.pdf


Second article relates to my search for longer term histories of asset returns for varying AA's. This article does not give any tables of such historical returns,but it does address the question "should one want longer histories"?

http://www.aametrics.com/pdfs/art_science_issue3.pdf
 
LOL! said:
Which types of accounts (taxable, tax-deferred, Roths) are the most efficient for which types of assets (fixed income, REITs, TIPS, large caps, small caps, value equities, etc).
Click to expand...
Taxes can be quite a drag on investment return. One can strive to have no taxable dividend and interest income and no realized capital gains each year. That is, your Form 1040 Schedule B and D can have no income. That'll can save you quite a bit on taxes. Go back to your previous tax returns and look at those schedules. Can you reduce your taxes?

Usually one will have a set of tax-deferred accounts (401(k), 403(b), traditional IRA), tax-free accounts (RothIRA) and taxable accounts as part of their asset allocation. How does one decide what investments are best in which accounts? Should the asset allocation of each account be similar or should one arrange things to achieve an overall asset allocation that has the best tax efficiency?

Many knowledgable folks state that one should combine all one's account into an overall asset allocation. One should put tax-inefficient investments into tax-free and tax-deferred accounts. One should use tax-efficient investments in taxable accounts. Here is a link that summarizes this and gives an order for which kinds of investments are tax-efficient: Bogleheads :: View topic - Investment Planning

Folks with only tax-deferred or tax-free investments have no worries with which investments to put in which accounts. But it may come as a surprise to folks with taxable and tax-deferred accounts that generally one should hold their fixed income, a low return investment, in a tax-deferred account and passive indexed large cap index funds in their taxable account. REITs and TIPS should be NOT be held in taxable accounts.

Dividends from fixed income investments like bonds held in a taxable account get taxed at your marginal income tax rate. If bonds and bond funds are held in a 401(k), then that income is tax-deferred until withdrawn later.

Unrealized capital gains are not taxed at all. It is only when an asset is sold is a potential gain realized and then taxed using the cap gains tax rate. The long term cap gains tax rate is lower than your marginal rate.

Thus if you have taxable accounts, one should not use an asset that puts out much in the way of dividends, interest or annual distributions. These kinds of investments are typically stock index ETFs, stock index mutual funds, large cap growth funds.

Value style funds tend to have a higher dividend rate, so would be better in a tax-deferred account. However, the dividend rate is not so much higher than a tax-efficient index fund. For example, the yield of the Vanguard Total Stock Market Index fund is 1.6% to 1.8%. The yield of the Vanguard Small Cap Value Index fund is about 2.0%.

International index funds are often tax-efficient and allow one to take the foreign tax credit for foreign taxes paid by the fund. But some fund-of-funds do not let the foreign tax credit to pass through.

There are some tax-managed funds out there. They may be no more tax efficient than the corresponding asset class index fund, but may have restrictions or back-end loads that would prevent tax-loss harvesting opportunities.

Tax-exempt bond funds should only be used if you need more fixed income and have no room in your tax-deferred accounts. A tax-exempt money market fund is good for folks in a high marginal income tax brackets. Compare your after-tax return of the taxable money market or savings account with the after-tax return of the tax-exempt MM fund.

Balanced funds and target retirement funds usually have a fixed income component to them, so they are not tax-efficient and should not be held in a taxable account.

There are more nuances to this, so ask questions or post links to articles to read.

Easy homework: Post the percentage of fixed income (taxable bond funds, the bond portion of balanced and TR funds) that you have in taxable accounts. Could you put that same amount in a bond fund in your tax-deferred accounts and replace the fixed income in your taxable account with a tax-efficient asset class? If you have tax-exempt bonds, would you come out ahead by using taxable bonds in a tax-deferred account or a Roth or a 529 plan?

My answer to the homework: I have about 30% fixed income in my asset allocation and 0% of that fixed income is found in my taxable accounts.
 
I don’t even know where I got this, but here is something I have been using (from least to most efficient). In parenthesis is the current % of our total portfolio in that type of fund in our taxable account.

Hi-Yield Bonds
Taxable Bonds
TIPS
REIT Stocks
Small-Value stocks
Small-Cap stocks (2%)
Large Value stocks (2%)
International stocks (2%)
Large Growth Stocks (4%)


Most stock index funds (6%)
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds (7.5%)


My biggest issue now is that I would have to take some very large gains in my taxable accounts, if I were to sell any of my less efficient funds now. Given my tax bracket, it seems to make more sense to hold them and make adjustments elsewhere, if possible.

We currently have 29% total in Bonds and 0% taxable. BUT – about 7.5% of these are in tax-free intermediate bonds in our taxable account. This might be a good example of where I could sell some of these with minimal gain, replace them with taxable bonds in our 401Ks and replace the allocation I lost in the 401K with a tax-efficient purchase in our taxable fund. I think I need to spend some time thinking about this and considering the options.

I also have realized that we probably don’t need the mid-cap allocation we have. I always wondered why you never heard a lot about mid-caps and now I know (generally trends with large). I think I probably need to shift my mid-caps into small-caps, which should be easy to do, as a lot of it is in our 401Ks. And I have always known my small value exposure was low, so I need to work to fix that.

Lastly, I agree with Darryl. Since reading, I have been looking around for some more foreign exposure in bonds and small caps – but haven’t seen much to my liking. And there is nothing offered in that area for our 401Ks. I have slowly consolidated everything I can into Vanguard – but they don’t seem to offer much in this area.


P.S - I generally review and adjust our portfolio each year over the holidays, so this exercise and review is very helpful to me! I will keep reading. It has been nice to have a little direction in the process. Thanks!
 
LOL! said:
Easy homework: Post the percentage of fixed income (taxable bond funds, the bond portion of balanced and TR funds) that you have in taxable accounts.
Click to expand...

Similar answer to yours, LOL, 20% in fixed income, 0% in taxable accounts.
-- Rita
 
KM said:
...
Lastly, I agree with Darryl. Since reading, I have been looking around for some more foreign exposure in bonds and small caps – but haven’t seen much to my liking. And there is nothing offered in that area for our 401Ks. I have slowly consolidated everything I can into Vanguard – but they don’t seem to offer much in this area.
Click to expand...
When I was trying to find a good fund or ETF for a particular asset class, I found the info at Eric Haas's altruistfa.com site helpful. Here is a link on the foreign small cap asset class: Foreign Dev Mkts Sml Cap Funds but there is lots more info on the site.
 
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